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Exchange Rate Economics

Author

Listed:
  • John Williamson
Abstract
Much of the paper is devoted to expounding the standard model of the exchange rate accepted by most economists today. This regards the exchange rate as a forward-looking asset price. Its steady-state level is determined by the need to have a current account balance that will keep the debt/gross domestic product (GDP) ratio constant, while the path of adjustment toward this steady-state level is determined by the representative agent's rational expectation of what will happen between now and the long run. The paper then examines a number of criticisms of this model: that exchange rate changes are driven by 'news' and will be nonexistent in the absence of news; that it implies that chartist rules will systematically lose money; and that it leaves no room for 'bubble-and-crash' dynamics, which appear to have occurred. An alternative 'behavioral' model that gives room for such behavior is presented. The paper then argues that overvaluation can thwart development through an attack of 'Dutch disease,' and discusses the role that exchange rate policy may play in avoiding this outcome. This demands primarily the use of nonmonetary instruments like fiscal policy or capital controls, but the behavioral model of the exchange rate implies that intervention can also play a role. The paper also includes a discussion of the alternative exchange-rate regimes available.

Suggested Citation

  • John Williamson, 2008. "Exchange Rate Economics," World Bank Publications - Books, The World Bank Group, number 28039.
    • Handle: RePEc:wbk:wbpubs:28039
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Finance and Financial Sector Development - Currencies and Exchange Rates Macroeconomics and Economic Growth - Economic Theory & Research Macroeconomics and Economic Growth - Macroeconomic Management Macroeconomics and Economic Growth - Fiscal & Monetary Policy;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy

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